Monetary Cause of Poverty

While poverty may be due to reasons most of which are already known in economics and sociology, it can also be looked at from another viewpoint, namely from the monetary viewpoint. Looked at from this angle, poverty may be significantly due to the structure of the global monetary system itself, particularly the fractional reserve banking system that is practiced worldwide.

The word ‘fractional reserve’ refers to the fraction from total deposits that banks must keep as reserve. This reserve ratio is determined and used by the central bank as one tool of monetary policy for controlling the money supply in the economy. The Bank Negara Malaysia, for example, imposes this reserve requirement on commercial banks as the Statutory Reserve Requirement (SRR). This reserve requirement determines the amount of money that commercial banks can create (The total = deposit ÷ SRR). The smaller the reserve requirement is, the more the money that can be created. For example, if the SRR is 4 percent, a RM1 million cash deposit can support a total deposit of RM25 million. The additional RM24 million can be introduced into the economy by the banking system in the form of loans. Opposed to currencies and coins in circulation, the money created by commercial banks takes the form of numerical or accounting money, circulated as cheques, credit card payments, electronic transfers, and the like. In other words, it is money created by means of mere accounting entries. The benefit of new money creation, known as seigniorage (the value given to money over and above its cost of production), accrues to the bank that lends it out at interest.

The fractional reserve banking and its accruing seigniorage have implications for asset ownership through their distributional effects, including the creation of poverty. Since fiat money is easy to create, most economies create too much of it relative to their ability to produce goods and services. This results in the growth in money supply that exceeds the growth of the real GDP, thereby causing inflation to reel (The table below, extracted from the writer’s book entitled The Theft of Nations, provides the statistics for some selected countries. The reader can easily guess which countries are likely to experience hyperinflation and hence socio-economic problems).

The socio-economic implications of this inflation arise from the fact that the newly created money does not accrue in the hands of every individual ‘evenly’. If the money or income of the people were to grow as the inflation rate does, then their real income would be intact and inflation would not be a problem. But true to the contrary, the new money created in the form of loans would instead go to corporations and individuals who are already relatively ‘well-off’ as only they are capable of depicting better credit-worthiness. A host of socio-economic problems would naturally result as a significant portion of the population does not experience income growth that would match the growth in money supply and the henceforth inflation rate.

This group would find its real income being gradually eroded by the annual growth in money supply, and hence the possibility of running into poverty. This increase in money supply can be aptly described as ‘inflation tax’, a tax on every individual in the economy that accrues to the one who creates and owns the money.

To illustrate the point, when a commercial bank extends a loan of RM300,000 for the purchase of an existing house, all individuals in the economy are actually financing the transfer of ownership of the house to the bank by means of inflation. This is because when the bank creates the additional RM300,000 through fractional reserve banking, there would now be more money in the economy relative to the real things and inflation would naturally come about. Initially, the bank neither had the RM300,000 nor the house. However, a mere accounting entry immediately places the ownership of the house with the bank. The implication of this is that the transfer of ownership is actually paid for by the entire economy through inflation. As a result, the seigniorage of the principal amount and interest accrues to the bank, all by means of mere numerical accounting only. The way money can be created with such ease would also mean the possibility of the excessiveness of its creation, and thus the ballooning of inflation. This inevitably forces governments to enforce price controls on basic necessities, particularly food items. The excessive money supply also creeps into other sectors and causes asset price bubbles, particularly in the stock and property markets. Furthermore, any productive activity whose profitability cannot match the interest rate would naturally ‘die-off’. The agricultural sector, being a much government-controlled sector, is particularly vulnerable to such a system, such that in many cases it warrants governments to subsidize the sector. Economically advanced countries, for that matter, still substantially subsidize their agriculture despite their highly modernized techniques in agricultural produce.

The property sector, being a sector that significantly absorbs money supply, would depict on average better growth and profitability. Price of homes and other properties on average are likely to grow faster than the general average inflation rate. This of course would pose housing problems for those pushed into the lower rung of the economy by the growing money supply in terms of real income. Home affordability would therefore gradually decrease, prompting calls for smaller homes, more flats, lowcost housing, longer mortgage durations, and other such price-cutting measures. Mortgage durations of 10 to 15 years were common during the 1970’s but banks today are even willing to extend them to as long as 35 years. There are even suggestions for two-generation mortgages.

Poverty can be caused by real economy, that is to say, by the lack of supply of real things. It can also be caused by the monetary system. In a modern capitalist economy, the creation of abundance of money that accrues very unevenly in the hands of individuals can aggravate poverty. Milton Friedman, a well-known monetary economist, says that inflation is predominantly a monetary phenomenon. If this is the case, the worsening of the global poverty problem can be significantly pointed at the institutions that are responsible for the creation of fiat money.

To tackle this problem, one of the imminent steps to be taken is the revamp of the local and global monetary systems that will tailor to a gradual move away from the fiat monetary system towards a system that is based on real money, such as gold.

Poverty eradication must, therefore, be approached not only from the real economy perspective, but also from the monetary perspective. The World Bank’s motto, namely ‘Working for a World Free of Poverty,’ has largely remained a utopian chase and rhetoric precisely because it is operating on the principles of fiat money and a global monetary system that lacks the mechanism for equitable distribution of wealth, that are ironically two of the defining causes of poverty.

Comments

I totally agree with this, except for the solution part where even “gold standard” may not be the best solution, but basically and more importantly I am totally aware of what problems does this system cause to world economies.

I am an economist, I like to think, as this year am graduating from Economics School in Bosnia and Herzegovina in Sarajevo. I also plan to write my thesis on this topic.

My motivation for this “project” was the question “Why the interest is forbidden in Islam?” ..always every path to a solution leads me to this..

In fact.. the whole world seems insecure today.. cause no matter how hard an good you work.. you always have the fear of tomorrow, because tomorrow you might not have anything to eat..

This is an interesting discussion. It says that the relative inbalance of money supply flows – where newly created money flows in greater amounts and at lower interest rates to large corporations than it does to individuals – can put individuals, homeowners, breadwinners, human beings at a mathematical disadvantage compared to artificial juristic persons like corporations. This means financially weaker individuals are forced into poverty over time – or are at the very least made poorer and have to struggle eternally just to keep afloat – because they experience higher inflation because of higher interest rates and price increases. This is easily explained, for instance, in terms of food, one of the sources of global inflation. Corporations don’t need food and are impervious to this phenomenon. But that is a simplistic example.
What interests me about this theory is its application to the global, macroeconomic environment. If smaller, weaker individuals can be disadvantaged by imbalances in money-supply flows, then can’t the same be said for weaker nation states? Are emerging markets not unfairly “taxed” by having to pay higher interest rates because of the risk ratings given to them by corporations like Moody’s and Standard & Poor’s. Your money-supply model is a classic one, one that most emerging markets subscribe to. But it ignores the US money supply theory which is called a “dynamic, stochastic interventionist model”. This model factors in the reality of the US being the world’s reserve economy and the global currency used to facilitate exchange of goods. Almost all commodities, if not all, commodities are being sold in dollars. In money-supply terms, that means that commodity producers are buying dollars every time they sell their commodities. All kinds of intangibles like CDOs, futures contracts and so on are also being created and traded in dollars. According to the US, this creates an uncertainty regarding the amount of dollars being traded or created at any one time anywhere in the world; ie, the amount of money supply is “stochastic” (uncertain, changing). It is “dynamic” because it is happening 24/7 and it is changing all the time and so forces the money supply authority into an eternal dance, trying to second guess the market to ensure an efficient supply of money that reflects real value. The authority must intervene occasionally in the market, as all reserve banks do. It must set interest rates for the best efficiency and fairness; it must intervene, the model is “interventionist”. But where is that groove of efficiency that determines when and where the authority must intervene/interfere with the market? According to US Fed chairman Ben Bernanke, know one can say. He’s of the opinion that, if Americans ever need money in a crisis, he can just get into a helicopter and fly over them and shower them with dollars because NO ONE in the world knows how many dollars are in circulation. That’s why he’s known in US reserve bank circles as Ben “Helicopter” Bernanke (you can Google it if you like).
The existence of this anomalous (compared to the rest of the world’s money-creation economies) circumstance means the US can make as many dollars as it can get away with. There is no groove of efficiency. The US can produce as many dollars as the world is willing to accept and to exchange with their economies. It appears after the credit crisis that Bernanke is right. The rest of the world through their bond markets and stock exchanges are continuously money laundering profligate US money supply and it appears the US authorities have no shame or any compunction to resist producing Frankenstein dollars. And our monetary authorities, tied by the umbilical cord to the world banking system, don’t have the political or moral will to resist. This means weaker nations are like households in a classic, capitalist economy. We too are being exposed to higher inflation and interest rate pressures. This is clearly to be seen in South Africa where we act as the output pipe to the carry trade – traders taking out low-interest-bearing loans in the US, for example, and lending the money out in a higher interest rate environment by buying single stock futures in South Africa, for example. They do nothing, add nothing of value, exchange their (worthless) dollars for real money, like rands, and take the profit from our economy back to theirs. In exchange for supporting our trade balance – caused by buying expensive technology for our national infrastructure spending programme geared to a Thatcherite programme of foreigners (US, EU) taking over our parastatals – we keep our interest rates high to fund western profligacy. So, we are kept poor because of the criminally insane money-supply model of the United States. According to Milton Friedman, nogal.

Hey dude, how are you? I was actually just spending some time searching through the internet for a bit of news and stumble’d upon your blog. I am so impressed by the information that you have written on this blog. It shows how well you understand this topic. Bookmarked this site, and will come back for more. Once again, thank you

Doc, I think this one could be re-titled as, “Monetary COST to Poverty”. And BTW, I’d strongly agree with you on the case of the World Bank. The fact its called “The World Bank” in itself is a connotation that it deals with monetary debt — and debt as we know it, is the shackles that keeps the poor, poor; and an instrument for the rich, to become richer.

Assalamualaikum Prof Dr. Ahamed Kameel,
I am really interested to study this subject (monetary and poverty) for my phd. Since last year, I’ve just realized that the root cause of the poverty all around the world today is might due to the paper currency and the riba ( ursury) practice. Therefore I think it is good for me to further understand on this subject especially when the world economic meltdown is about to happen now.
The problem is my academic background is on electrical engineering (1st degree) and engineering Management(master). This means i dont have any economics background. Furthermore,since currently I am working as a manager at Telekom Malaysia, I would like to do the study on part time basis. Unless there is any good scholarship, maybe I could proceed with fulltime.
Appreciate your comments and recommendations.

Can’t generate income still? Well that’s because each one of these rubbish scammers keep separating us from our hard earned money! we have to get started weeding through the scams and start going to those who actully really want you to do well. the good news is i just created a website just about that!

how far or rather how much have we done in the effort of revamping the present “riba” based monetary system.. and how much support has the returning Dinar and Dirham currency system received from academicians like you and your colleagues.

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